nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2006‒12‒16
fifteen papers chosen by
Christian Zimmermann
University of Connecticut

  1. On the equilibrium in a discrete-time Lucas Model By Marius Boldea
  2. Learning your earning: are labor income shocks really very persistent? By Fatih Guvenen
  3. Ben-Porath meets skill-biased technical change: a theoretical analysis of rising inequality By Fatih Guvenen; Burhanettin Kuruscu
  4. Urban structure and growth By Esteban Rossi-Hansberg; Mark L. J. Wright
  5. Ramsey meets Hosios: the optimal capital tax and labor market efficiency By David M. Arseneau; Sanjay K. Chugh
  6. The Role of Debt and Equity Finance over the Business Cycle By Francisco Covas; Wouter J. den Haan
  7. A model in which outside and inside money are essential By David C. Mills, Jr.
  9. Inefficiency of competitive equilibrium with hidden action and financial markets By Luca, PANACCIONE
  10. Closing open economy models By Martin Bodenstein
  11. Establishment size dynamics in the aggregate economy By Esteban Rossi-Hansberg; Mark L. J. Wright
  12. Equilibrium Layoff as Termination of a Dynamic Contract By Wang, Cheng
  13. Business cycles: a role for imperfect competition in the banking system By Federico S. Mandelman
  14. Oil dependence and economic instability By Luís Aguiar-Conraria; Yi Wen
  15. Disagreement and learning in a dynamic contracting model By Tobias Adrian; Mark M. Westerfield

  1. By: Marius Boldea (CES - Centre d'économie de la Sorbonne - [CNRS : UMR8174] - [Université Panthéon-Sorbonne - Paris I])
    Abstract: In this paper I study a discrete-time version of the Lucas model with the endogenous leisure but without physical capital. Under standard conditions I prove that the optimal human capital sequence is increasing. If the instantaneous utility function and the production function are Cobb-Douglas, I prove that the human capital sequence grow at a constant rate. I finish by studying the existence and the unicity of the equilibrium in the sense of Lucas or Romer.
    Keywords: Lucas Model, human capital, externalities, optimal growth, equilibrium.
    Date: 2006–12–06
  2. By: Fatih Guvenen
    Abstract: The current literature offers two views on the nature of the labor income process. According to the first view, which we call the “restricted income profiles” (RIP) model, individuals are subject to large and very persistent shocks while facing similar life-cycle income profiles (MaCurdy, 1982). According to the alternative view, which we call the “heterogeneous income profiles” (HIP) model, individuals are subject to income shocks with modest persistence while facing individual-specific income profiles (Lillard and Weiss, 1979). In this paper we study the restrictions imposed by the RIP and HIP models on consumption data—in the context of a life-cycle model—to distinguish between these two hypotheses. In the life-cycle model with a HIP process, which has not been studied in the previous literature, we assume that individuals enter the labor market with a prior belief about their individual-specific profile and learn over time in a Bayesian fashion. We find that learning is slow, and thus initial uncertainty affects decisions throughout the life cycle. The resulting HIP model is consistent with several features of consumption data including (i) the substantial rise in within-cohort consumption inequality, (ii) the non-concave shape of the age-inequality profile, and (iii) the fact that consumption profiles are steeper for higher educated individuals. The RIP model we consider is also consistent with (i), but not with (ii) and (iii). These results bring new evidence from consumption data on the nature of labor income risk.
    Date: 2006
  3. By: Fatih Guvenen; Burhanettin Kuruscu
    Abstract: In this paper we present an analytically tractable general equilibrium overlapping-generations model of human capital accumulation, and study its implications for the evolution of the U.S. wage distribution from 1970 to 2000. The key feature of the model, and the only source of heterogeneity, is that individuals differ in their ability to accumulate human capital. Therefore, wage inequality results only from differences in human capital accumulation. We examine the response of this model to skill-biased technical change (SBTC) theoretically. We show that in response to SBTC, the model generates behavior consistent with the U.S. data including (i) a rise in overall wage inequality in both the short run and long run, (ii) an initial fall in the education premium followed by a strong recovery, leading to a higher premium in the long run, (iii) the fact that most of this fall and rise takes place among younger workers, (iv) stagnation in median wage growth (and a slowdown in aggregate labor productivity), and (v) a rise in consumption inequality that is much smaller than the rise in wage inequality. These results suggest that the heterogeneity in the ability to accumulate human capital is an important feature for understanding the effects of SBTC, and interpreting the transformation that the U.S. economy has gone through since the 1970s.
    Date: 2006
  4. By: Esteban Rossi-Hansberg; Mark L. J. Wright
    Abstract: Most economic activity occurs in cities. This creates a tension between local increasing returns, implied by the existence of cities, and aggregate constant returns, implied by balanced growth. To address this tension, we develop a general equilibrium theory of economic growth in an urban environment. In our theory, variation in the urban structure through the growth, birth, and death of cities is the margin that eliminates local increasing returns to yield constant returns to scale in the aggregate. We show that, consistent with the data, the theory produces a city size distribution that is well approximated by Zipf’s Law, but that also displays the observed systematic under-representation of both very small and very large cities. Using our model, we show that the dispersion of city sizes is consistent with the dispersion of productivity shocks found in the data.
    Date: 2006
  5. By: David M. Arseneau; Sanjay K. Chugh
    Abstract: Heterogeneity between unemployed and employed individuals matters for optimal fiscal policy. This paper considers the consequences of welfare heterogeneity between these two groups for the determination of optimal capital and labor income taxes in a model with matching frictions in the labor market. In line with a recent finding in the literature, we find that the optimal capital tax is typically non-zero because it is used to indirectly mitigate an externality along the extensive labor margin that arises from search and matching frictions. However, the consideration of heterogeneity makes our result differ in an important way: even for a well-known parameter configuration (the Hosios condition) that typically eliminates this externality, we show that the optimal capital income tax is still non-zero. We also show that labor adjustment along the intensive margin has an important effect on efficiency at the extensive margin, and hence on the optimal capital tax, independent of welfare heterogeneity. Taken together, our results show that these two empirically-relevant features of the labor market can have a quantitatively-important effect on the optimal capital tax.
    Date: 2006
  6. By: Francisco Covas; Wouter J. den Haan
    Abstract: The authors show that debt and equity issuance are procyclical for most listed U.S. firms. The procyclicality of equity issuance decreases monotonically with firm size. At the aggregate level, however, the authors' results are not conclusive: issuance is countercyclical for very large firms that, although few in number, have a large effect on the aggregate because of their enormous size. If firms use the standard one-period contract, then the shadow price of external funds is procyclical and the cyclicality decreases with firm size. This property generates equity to be procyclical and--as in the data--the procyclicality decreases with firm size. Other factors that cause equity to be procyclical in the model are a countercyclical price of risk and a countercyclical cost of equity issuance. The model (i) generates a countercyclical default rate, (ii) magnifies shocks, and (iii) generates a stronger cyclical response for small firms, whereas the model without equity does the exact opposite.
    Keywords: Financial stability; Business fluctuations and cycles
    JEL: E3 G1 G3
    Date: 2006
  7. By: David C. Mills, Jr.
    Abstract: I present an environment for which both outside and inside money are essential as means of payment. The key model feature is that there is imperfect monitoring of issuers of inside money. I use a random matching model of money where some agents have private trading histories and others have trading histories that can be publicly observed only after a lag. I show via an example that for lags that are neither too long nor too short, there exist allocations that use both types of money that cannot be duplicated when only one type is used. Inside money provides liquidity that increases the frequency of trades, but incentive constraints restrict the amount of output that can be traded. Outside money is immune to such constraints and can trade for higher levels of output.
    Date: 2006
  8. By: Martin Menner
    Abstract: Shouyong Shi(1998) presents a general equilibrium model which shows a persistent monetary propagation mechanism. There the high persistence is obtained by a combination of search frictions in the goods and labor markets and the presence of final goods inventories. The present paper addresses the question of robustness of these results, especially, how sensitive are Shi's results to parameter changes and to different model specifications. Calibration of the parameters to intervals is used to perform a global sensitivity analysis. The calibration exercise reveals that the model is quite robust to changes in parameters. Comparing different model versions - including a CIA model which appears as a special case when buyers and sellers match always - we can disentangle and quantify the contributions of the various frictions in accounting for the persistent propagation. Search-frictions in the goods market and inventory holdings are necessary for persistent propagation of monetary shocks. Labor market frictions are not crucial but prolong the output responses and reduce their magnitude.
    Date: 2006–11
    Abstract: In this paper, we study a pure exchange economy with idiosyncratic uncertainty, hidden action and multiple consumption goods. We consider two different market structures : contingent markets on the one hand, and financial and spot markets on the other hand. We propose a competitive equilibrium concept for each market structure. We show that the equilibrium with contingent markets is efficient in an appropriate sense, while the equilibrium with financial and spot markets is inefficient, provided that assumptions on preferences more general than those usually considered in the literature hold.
    Keywords: Hidden action, enforcement, constrained efficiency
    JEL: D61 D82
    Date: 2006–09–15
  10. By: Martin Bodenstein
    Abstract: Several methods have been proposed to obtain stationarity in open economy models. I find substantial qualitative and quantitative differences between these methods in a two-country framework, in contrast to the results of Schmitt-Grohé and Uribe (2003). In models with a debt elastic interest rate premium or a convex portfolio cost, both the steady state and the equilibrium dynamics are unique if the elasticity of substitution between the domestic and the foreign traded good is high. However, there are three steady states if the elasticity of substitution is sufficiently low. With endogenous discounting, there is always a unique and stable steady state irrespective of the magnitude of the elasticity of substitution. Similar to the model with convex portfolio costs or a debt elastic interest rate premium, though, there can be multiple convergence paths for low values of the elasticity.
    Date: 2006
  11. By: Esteban Rossi-Hansberg; Mark L. J. Wright
    Abstract: Why do growth and net exit rates of establishments decline with size? What determines the size distribution of establishments? This paper presents a theory of establishment dynamics that simultaneously rationalizes the basic facts on economy-wide establishment growth, net exit, and size distributions. The theory emphasizes the accumulation of industry-specific human capital in response to industry-specific productivity shocks. It predicts that establishment growth and net exit rates should decline faster with size and that the establishment size distribution should have thinner tails in sectors that use human capital less intensively or physical capital more intensively. In line with the theory, the data show substantial sectoral heterogeneity in U.S. establishment size dynamics and distributions, which is well explained by variation in physical capital intensity.
    Date: 2006
  12. By: Wang, Cheng
    Abstract: In a dynamic model of the labor market with moral hazard, equilibrium layoff is modeled as termination of an optimal long-term contract. Termination, together with compensation (current and future), is used as an incentive device to induce worker efforts. I then use the model to study analytically the effects of a firing tax on termination and worker compensation and utility. There are three layers to the impact of a firing tax on layoff and worker utility. A higher firing tax could either reduce aggregate termination and increase worker utility, or increase aggregate termination and reduce worker utility, depending on the structure of the environment.
    Date: 2006–12–11
  13. By: Federico S. Mandelman
    Abstract: This paper studies the cyclical pattern of ex post markups in the banking system using balance-sheet data for a large set of countries. Markups are strongly countercyclical even after controlling for financial development, banking concentration, operational costs, inflation, and simultaneity or reverse causation. The countercyclical pattern is explained by the procyclical entry of foreign banks, which occurs mostly at the wholesale level and signals the intention to spread to the retail level. My hypothesis is that wholesale entry triggers incumbents' limit-pricing strategies, which are aimed at deterring entry into retail niches and which, in turn, dampen bank markups. In the second part of the paper, I develop a general equilibrium model that accounts for these features of the data. I find that this monopolistic behavior in the intermediary financial sector increases the volatility of real variables and amplifies the business cycle. I interpret this bank-supply channel as an extension of the credit channel pioneered by Bernanke and Blinder (1988).
    Date: 2006
  14. By: Luís Aguiar-Conraria; Yi Wen
    Abstract: We show that dependence on foreign energy can increase economic instability by raising the likelihood of equilibrium indeterminacy, hence making fluctuations driven by self-fulfilling expectations easier to occur. This is demonstrated in a standard neoclassical growth model. Calibration exercises, based on the estimated share of imported energy in production for several countries, show that the degree of reliance on foreign energy for many countries can easily make an otherwise determinate and stable economy indeterminate and unstable.
    Keywords: Petroleum industry and trade ; Economic stabilization
    Date: 2006
  15. By: Tobias Adrian; Mark M. Westerfield
    Abstract: We present a dynamic contracting model in which the principal and the agent disagree about the resolution of uncertainty, and we illustrate the contract design in an application with Bayesian learning. The disagreement creates gains from trade that the principal realizes by transferring payment to states that the agent considers relatively more likely. The principal?s value function is convex in the underlying belief differences because the more optimistic the agent, the greater the incentives and the smaller the agent?s required compensation. Under risk neutrality, selling the firm to the agent does not implement the first-best outcome, because it precludes state-contingent trades.
    Keywords: Contracts ; Uncertainty ; Econometric models ; Microeconomics
    Date: 2006

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